9 - Tax incidence and efficiency costs of taxation Flashcards
what is tax incidence
the effect of a tax on prices and the distribution of economic welfare
- changes in economic equilibria when taxes change
- what policy maximises welfare
what is legislative/statuatory incidence
who is required by law to pay the tax
what is economic incidence
who faces the burden of the tax
what is the difference between an excise tax and ad-valorem tax
- excise tax = levied on a quantity
($1 per pack) - ad valorem = fraction of prices (5% sales tax)
what are the 2 different prices faced by consumers and producers when tax introduced
producer - p
consumer - pc = p + t
when do consumers bear the entire tax burden
- ed = 0
- inelastic demand
- es = infinity
- perfectly elastic supply
when do producers bear the entire burden of tax
- es = inelastic supply
- ed = perfectly elastic demand
what is the general rule for who bears the burden of the tax more
more inelastic factor bears more of the tax
what is deadweight burden
the welfare loss
- change in CS + PS
- individuals and firms making inefficient consumption and production choices to avoid taxation
what is the size of DWL related to
the extent which C and P change their behaviour to avoid tax
under what circumstances will a tax change not have any efficiency costs
- no DWL
- when the quantity doesnt change
- when demand is inelastic
what is DWB relationship with elasticities
DWB increases with absolute sixe of elasticities
taxing which types of goods is more efficient - has lowest DWL
best to tax inelastic goods
- less DWL
what are the 3 factors that will increase DWL?
- larger absolute elasticities of supply/demand
- the size of tax
- small taxes = relatively small efficiency costs - pre-existing distortions
- already existing tax
Oates (2015)
what did they find
- find evidence of bunching below notches
- taxes on window
- see how the number of windows changes
- the more elastic agents = the higher the welfare cost - the more responsive
what is the most efficient way to decide how to tax different goods that raise a given amount of revenue while minimising DWL to an individual
- Ramsey tax rule
what is the Ramsey tax rule
optimum tax rate such that marginal DWL for last dollar of tax collected is the same across all goods
- tax inelastic demand goods more
why is uniform tax rates less efficient than ramsey tax rule
- uniform = more elastic goods will generate larger efficiency costs
- better to tax more the inelastic goods
Benzarti (2020)
what did they test and do
want to test the effects of VAT rates increasing and decreasing
- what happened with tax incidence of VAT cut
- Finland got VAT cut of 14 points in jan 2007, that was repealed in 2012
- diff in diff
- analysis of prices of treatment (hairdressers) + control (beauty salons)
Benzarti (2020)
what did they find
14% tax cut
- when tax cut 2007
- tax incidence was 50-50 between hairdressers and consumers
- hairdressers pocket 7%
- consumers face 7% lower prices
- when tax cut increased by 14% again
- hairdressers pass all of tax increase to consumers
- full tax incidence on consumers
- prices end up higher than the control in the end
what can explain asymmetries
asymmetries between tax cut and tax increase
why: consumers are inattentive to taxes, so producers can pocket tax decreases, and justify tax increases to consumers
what are the 3 goals governments have in mind when cutting taxes VAT
- decrease P and increase D
- increase cash flow/profits
- increase wages
why does tax incidence make government policies hard
- governments might try and target consumers
- but producers take the incidence of the tax cut
- so tax cut reform doesnt end up helping consumers at all
what does tax incidence depend on
determined by relative magntitude of demand and supply elasticities
- limits gov policies
can governments affect tax incidence
yes
- they can through using madates and monitoring systems
- but the mandates are hard to implement and enforce
- and unexpected incidence effects mean may not target the right people
Benzarti & Tortarolo (2022)
Benzarti and Tortarolo (2022)
what do the do
what are they testing
- test if government can affect tax incidence through mandates
- exploit large and temporary VAT cut on 13 categories of basic food in Argentina supermarkets
- look at small and large chains
- uses price monitoring in large supermarkets
Benzarti and Tortarolo (2022)
what do they find
how much of tax cut was passed through as lower prices to consumers
- large supermarket = 85%
- small supermarket = 35%
* gov was successful at engineering price decreases
- after VAT increased - for small stores price increased above og value, for large stores prices fell
- low income hhs shop more at small supermarkets - so really this VAT cut did not effect them that much (targeted group) = unexpected effects
how does adding salience into tax incidence formula change things?
if pheta = 0
if pheta = 1
- 0 –> producers tax incidence is 0
- all burden on consumers - 1 –> tax incidence depends on elasticities
what does
pheta = 0
pheta = 1
mean
0 = consumers are not salient - not attentive of taxes
1 = consumers are fully attentive
what are the 2 methods to test whether salience matters for sales tax incidence
- randomised field experiment
- policy experiment
Chetty (2009)
- salience and sales tax
what did they do
randomised field experiment
- treatment store = display price tags with sales tax and total price - for a subset of products
- control = products in the treated store
- diff in diff
- repeat analysis in control stores as placebo DD strategy
- if we see that sales go down - then increased salience = reduce demand - but condusion playing role??
Chetty (2009)
- salience and sales tax
what did they do
policy experiment
- compares tax changes made to beer exicses and sales tax of equal size
- change in beer excise and sales taxes across US
- posted price on tag = salient
- tax added at till = not salient
Chetty (2009)
- salience and sales tax
what did they find
policy experiment
beer consumption
find that salience matters
- the more salient the tax - behaviours change = demand changes
- beers excise states
- states that increased tax - see lower demand
- states that decreased tax - see higher demand
only seen for beer
- equally big changes in tax for sales tax rate dont see change in demand
how does salience of consumers relate to DWL
- the less salient they are
- the less elastic they are - less responsive
- more likely to take on the tax burden
- less DWL
what does posting the sales tax do to demand
decrease demand if sales tax increases
what is general equilibrium tax incidence
how does imposing tax in one market effect other markets
